It was mentioned (in part 2) that a currency-issuing government issues its currency in the act of spending. An implication of this is that a currency-issuing government does not need income in order to spend. We have also noted (in parts 5 and 9) that a household or business can spend independently of current income. They can do this either by drawing down past savings or through borrowing.
Now, if we think about past savings, these are the result of saving in an earlier period. This saving of an earlier period was only possible because of income received in that period. We know this because saving, by definition, is that part of disposable income not consumed. It is impossible to save unless you have an income.
The significance of this is that, in trying to explain how spending can occur without prior income, the role of past savings does not get us very far. This is because those savings were themselves the result of past spending. If we went all the way back to the beginning, before any spending had occurred and so before any income had been created, there would be no savings.
Imagine a monetary economy at its inception. The very first act of spending would have to come from something other than income or past savings. It could not come from income because initially there would be no income, no spending having yet occurred. And it could not come from prior savings, because there can’t be any savings before the first income has been created.
If we exclude past savings, that leaves two main ways that spending can occur. It can occur either through:
1. government spending; or
2. private spending financed by borrowing.
From inception of a monetary economy with a national currency, government will be the first spender in the currency, because it needs to put various institutional arrangements in place, and this requires paying staff a monetary wage (see part 2). But once the monetary economy is up and running, it is also possible for a household or business to spend in the national unit of account without prior savings, through borrowing.
At first glance, these solutions to our apparent riddle may seem to raise more questions than they answer.
In relation to the first solution, it might be wondered, doesn’t a government need tax revenue before it can spend? Or, lacking tax revenue, doesn’t it need to borrow from the private sector? Without income or prior savings already in existence, wouldn’t government spending be impossible?
In relation to the second solution, it might be asked, doesn’t a bank or other private lender need funds to be deposited with it before it can lend?
Without any income, there would be no tax payments, nor any funds deposited with lenders. So, logically speaking, how could spending possibly occur?
It might seem as if we are facing a “chicken and egg” problem.
But fortunately we are not. Spending does indeed come first.
A currency-issuing government can, and does, spend without an income. And commercial banks can, and do, extend loans without drawing upon the funds deposited with them.
To see how these things are possible, we need to think a little about the nature of money. In particular, we will need to understand:
- government money; and
- commercial bank money.
But before considering these, it will be helpful to consider the nature of money in general.